Fed extends debt-buying plan, leaves rates unchanged

Cautious stance seen from central bank

WASHINGTON (MarketWatch) - The Federal Reserve held interest rates steady at historic lows Wednesday, deciding it was too soon to rollback more of its rescue efforts.

The Fed cautiously welcomed the improving economy and slightly slowed down its debt-buying plans as it buys time to monitor how the nation recovers from the worst recession in 80 years.

"Nobody at the Fed thinks now is the right time" to embark on exit strategies, said former Federal Reserve vice-chairman Alan Blinder. This sentiment is likely to remain in place at the Fed's next meeting in early November, he added.

Fed officials said that economic activity has "picked up" with improved conditions in housing and financial markets. Businesses are slowing down their efforts to cut costs, according to the Fed statement, which came after a closed-door, two-day meeting of the Federal Open Markets Committee.

At first stocks soared after the statement was released but then pulled back sharply to close at session lows as the dollar declined further. See full story.

As statements of economic recovery go, this was hardly in the "jump for joy" category, noted Josh Shapiro, chief U.S. economist at MFR Inc.

In a decision watched closely by the bond markets, the Fed announced that it has extended its purchase of mortgage-backed securities and agency debt into the first quarter of 2010.

Analysts had expected the move, which smoothes out the purchases.

The Fed has purchased $857 billion of its scheduled $1.25 trillion in mortgage-backed securities, according to Morgan Stanley. It's also bought $129.2 billion of the planned $200 billion in so-called agency debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks, which finance mortgage purchases.

Those programs had been officially expected to end in December.

Analysts noted that the Fed gave itself some wiggle room by saying that it would purchase "up to" $200 billion in agency debt.

As expected, the Fed kept its target for its federal funds rate set at a range of zero to 0.25%.

The Fed repeated that it "continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Read full FOMC statement

Bill Cheney, chief economist at John Hancock in Boston, said the Fed was being extremely cautious.

"They think the economy is going to grow but it is not a real sure thing - it may need help," Cheney said.

There wasn't much in the statement for the market to chew over, he said. "It is pretty much what everyone else thinks," Cheney said.

The Fed has said it will keep the pedal to the metal for as long as the eye can see - Cheney said.

"This remains a very dovish Fed," much more worried about growth than inflation, said Steve Stanley, chief economist at RBS Securities Inc.

The vote by the committee was unanimous. There had been market chatter of a possible dissent.

Economists expect the Fed to hold interest rates close to zero into sometime in 2010. Some see no action at all until 2011.

The language in the statement mirrors, but does not exactly follow, comments made last week by Fed Chairman Ben Bernanke, who said he thought the recession was likely over.

This recession has been the longest and deepest since World War II. But Fed officials see signs that growth could remain slow for a long time.

By extending the debt-buying until the end of March 2010, the Fed has given itself about seven more months to see how things develop.

Bond analysts didn't expect any change to the Fed's Treasury-buying program, and the Fed did repeat that they anticipate purchasing $300 billion in U.S. debt by the end of October. The Fed has just $11 billion left under that program, according to Cantor Fitzgerald.

"Information received since the FOMC met in August suggests that economic activity has picked up following its severe downturn," the Fed said in its statement.

For the first time since 2005 the Fed was able to say that "activity in the housing sector has increased."

Businesses are still cutting back on fixed investment and staffing, "though at a slower pace," the Fed said.

Despite the constant drumbeat about inflation, especially on business cable news programs, the Fed was clear that it expects inflation would remain in check.

"With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time," the statement said.

The Fed also removed language from its August statement expressing concern about rising prices for energy and other commodities.

Greg
Robb

Greg Robb is a senior reporter for MarketWatch in Washington. Follow him on Twitter @grobb2000.

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